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The U.S. Economic Situation and Regulatory Reform James Bullard President and CEO Federal Reserve Bank of St. Louis A Day with the Commissioner Nashville, TN 12 May 2010 Any opinions expressed here are my own and do not necessarily reflect those of the Federal Open Market Committee participants. This Talk State of the U.S. economy Tennessee's economy The global economy Monetary policy Risks to the outlook Financial regulatory reform State of the U.S. Economy Continued signs of recovery Real Gross Domestic Product Actual and forecasted, percent change from previous quarter at annual rate Percent 8 6 4 2 0 -2 -4 -6 2007 2008 2009 2010 2011 Real GDP Growth Apr-2010 BC Forecast Apr-2010 MA Forecast -8 Source: Bureau of Economic Analysis, Macroeconomic Advisers, Blue Chip Economic Indicators. GDP expected to reach 2008:Q2 peak before year-end Real Gross Domestic Product and MA Forecast (As of May 10, 2010) 2007:Q1 = 100 104 103 102 101 100 99 98 2007 2008 2009 2010 Source: Bureau of Economic Analysis, Macroeconomic Advisers. Composition of real output Components of Real Gross Domestic Product 2007Q1 = 100 Nondurables plus services consumption 105 100 95 90 Durables consumption 85 80 75 Investment 70 65 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Source: Bureau of Economic Analysis. Home prices are increasing but remain low S&P Case Shiller House Prices and Nominal GDP 2001Q1=1 1.8 1.6 U.S. National S&P Case-Shiller Price Index 1.4 1.2 Nominal GDP 1 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Bureau of Economic Analysis, S&P, Fiserv, and MacroMarkets LLC. Manufacturing has rebounded Industrial Production and the ISM Manufacturing Index Percent Change from Previous Month 2 Index 60 55 1 50 0 45 -1 40 Industrial Production (Left Axis) -2 35 ISM Manufacturing (Right Axis) -3 30 -4 25 2007 2008 2009 2010 Source: Federal Reserve Board/Institute of Supply Management. Labor market conditions are slowly improving Nonfarm Payroll Employment Growth Change from previous month. 290 thousand jobs gained in April 66 thousand were Census-related Thousands 400 200 0 -200 -400 -600 -800 -1000 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Source: Bureau of Economic Analysis, S&P, Fiserv, and MacroMarkets LLC. Unemployment remains high Unemployment and Initial Claims Thousands Percent 12 700 650 Jan.-Mar. 9.7% 11 Apr. 9.9% Unemployment Rate, SA (Right Axis) 600 550 500 10 Initial Claims for Unemployment Insurance, 4-wk moving average (Left Axis) 9 450 8 400 7 350 6 300 5 250 200 2007 4 2008 2009 2010 Source: Bureau of Labor Statistics/Department of Labor. Tennessee's Economy Payroll employment during the recession Dec. 2007=100 101 99 97 U.S. 95 Nashville MSA Tennessee 93 91 Jan-2008 Memphis MSA Apr-2008 Jul-2008 Oct-2008 Jan-2009 Apr-2009 Jul-2009 Oct-2009 Jan-2010 Unemployment rate Percent 12 11 Tennessee 10 Nashville MSA 9 8 7 U.S. Memphis MSA 6 5 4 Jan-2008 Apr-2008 Jul-2008 Oct-2008 Jan-2009 Apr-2009 Jul-2009 Oct-2009 Jan-2010 2009.Q4 2009.Q3 2009.Q2 0.8 2009.Q1 2008.Q4 1.4 2008.Q3 2008.Q2 2008.Q1 2007.Q4 2007.Q3 2007.Q2 2007.Q1 2006.Q4 2006.Q3 2006.Q2 2006.Q1 2005.Q4 2005.Q3 2005.Q2 2005.Q1 Foreclosure trends Foreclosure Rate (% of Mortgages in Foreclosure) 1.6 U.S. 1.2 1 Tennessee 0.6 0.4 0.2 0 Tennessee’s fiscal picture 2007 2008 2009 Mill. of $ Mill. of $ (Prev. year % ch.) Mill. of $ (Prev. year % ch.) 1,067 922 (-14.6%) 847 (-8.5%) -23.1 % Sales Taxes (Tenn.) 6,913 6,723 (-2.8%) 6,173 (-8.5%) -11.3% Total Taxes (Tenn.) 11,314 11,224 (-0.8%) 10,362 (-8%) -8.8% Total Taxes for All States 694,320 772,612 (+10.7%) 684,562 (-12.1%) -1.4% Corporate Income Taxes (Tenn.) % Change 2007-2009 Source: Nelson A. Rockefeller Institute of Government. The Global Economy Global growth Canada 5.0, 5.0, 4.0 U.S. 5.6, 3.2, 4.0 Latin America 6.5, 4.8, 4.3 Russia U.K. 15.0, 9.4, 7.0 1.8, 1.3, 2.6 China EU 9.6, 10.8, 8.4 0.2, 0.3, 1.9 Japan India -2.2, 12.0, 9.0 3.8, 5.2, 2.9 South Africa 3.2, 4.3, 4.4 Australia 1.9, 4.7, 2.5 Real GDP growth, SAAR, Percent, 2009:Q4, 2010:Q1, and 2010:Q2 Source: Barclays Capital Global Economic Weekly. U.S. leads major partners in productivity Output per Employed Person Index, 2007:Q1 = 100 107 105 103 United States 101 99 Canada Euro Area 97 95 Japan U.K. 93 2007:1 2007:2 2007:3 2007:4 2008:1 2008:2 2008:3 2008:4 2009:1 2009:2 2009:3 2009:4 Source: Board of Governors. But the U.S. shed a larger percentage of the workforce Employment Index, 2007:Q1 = 100 103 102 Canada 101 100 U.K. 99 Euro Area 98 Japan 97 96 United States 95 94 2007:1 2007:2 2007:3 2007:4 2008:1 2008:2 2008:3 2008:4 2009:1 2009:2 2009:3 2009:4 2010:1 Source: Board of Governors. Monetary Policy Near-zero policy rates in the G-7 Percent 6 U.K 5 Canada 4 Euro Area 3 2 1 0 2007 U.S. Japan 2008 2009 2010 Federal Reserve balance sheet Billions $ 3,000 2,500 Short-Term Lending to Financial Firms and Markets Rescue Operations Asset Purchase Program 2,000 Traditional Portfolio 1,500 Traditional Portfolio and Long-Term Assets 1,000 500 0 Jan-2007 Jul-2007 Jan-2008 Jul-2008 Jan-2009 Jul-2009 Jan-2010 Source: Board of Governors. Inflation remains low Headline CPI Inflation and Core CPI Inflation (Year-over-year percent change. Monthly data. Last observation: March 2010.) Percent 6 5 Headline CPI Inflation 4 3 2 Core CPI Inflation 1 0 -1 2003 2004 2005 2006 2007 2008 2009 2010 -2 -3 Source: Bureau of Labor Statistics. Risks to the Outlook Sovereign credit protection Five Year CDS Daily, Last Observation is May 10, 2010 Basis points 1000 800 Greece 600 586 400 Portugal Spain 200 0 May-08 Italy U.S. Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Source: Bloomberg LP. Flight to safety 10-Year Treasury Note Yield at Constant Maturity Daily data as of May 10, 2010 Average, % p. a. 4.1 4.0 3.9 3.8 3.7 3.57 3.6 3.5 3.4 3.3 Jan-2010 3.41 Feb-2010 Mar-2010 Apr-2010 May-2010 Source: Federal Reserve Board. LIBOR-OIS spread Basis Points 400 350 300 250 200 1-Month 3-Month 6-Month 150 100 50 0 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Source: Reuters and Financial Times. U.S. state debt burdens Debt Ratios of the 10 Most Populous States Ranked by Ratio of Debt to Personal Income State Moody’s / S&P/ Fitch Debt to Personal Income Debt per Capita Texas Aa1/AA+/AA+ 1.4% $520 Michigan Aa3/AA-/A+ 2.2% $766 Pennsylvania Aa2/AA/AA 2.5% $950 Ohio Aa2/AA+/AA 2.8% $962 Florida Aa1/AAA/AA+ 2.9% $1,115 Georgia Aaa/AAA/AAA 3.0% $984 Baa1/A/BBB 4.4% $1,805 A1/AA-/A 4.6% $1,877 New York Aa3/AA/AA- 6.3% $2,921 New Jersey Aa3/AA/AA- 7.3% $3,621 California Illinois Source: The State of California Debt Affordability Report October 2009. Financial Regulatory Reform Community banks Regulation works well for the thousands of community banks in the U.S. The system features deposit insurance plus prudential regulation. The system allows failure—capitalism at work—but prevents bank runs and the associated panic. Community banks did not cause the crisis and do not need to be re-regulated. The Fed and community bank regulation Some regulatory proposals would have created a “Wall Street only” Fed. The Fed should remain involved with community bank regulation so that it has a view of the entire financial landscape. It is important that the Fed does not become biased toward the very large, mostly New York-based institutions. Community banks tend to fund smaller businesses, an important source of job growth for the economy. Understanding this process helps the Fed make sound monetary policy decisions. Fed structure The Federal Reserve has three parts. Washington: Board of Governors. New York: One bank in the nation’s financial capital. Main Street: Eleven banks in the rest of the nation. The regional structure was designed to keep some power out of New York and Washington. It allows for input on key policy questions from around the U.S. This system has been very successful. Fed governance The Board of Governors members are appointed by the President and confirmed by the U.S. Senate. The Board of Governors has oversight authority for the Fed. This includes budget authority. It also includes authority over key appointments in the Fed. This means Presidents, First Vice-Presidents, as well as the Chair and ViceChair of the Board of Directors at each Reserve Bank. There is considerable accountability in the Roosevelt-era re-design of the Federal Reserve. Auditing monetary policy Monetary policy is vigorously debated every day, both inside and outside the Fed. The Fed is extensively audited—our rough estimate is about 425,000 hours annually: Internal audit function. Board of Governors oversight. External auditor (Deloitte). Each hour of audit time requires staff time for compliance. In addition, the Fed is subject to auditing by the GAO, the investigative arm of Congress. Additional audits are welcome, so long as they do not constitute political meddling. Federal Reserve independence Allowing short-term politics to mix too closely with monetary policy leads to poor economic outcomes. This has occurred frequently in the developing world over the past 50 years. In the U.S., erosion of Fed independence could result in a 1970s-style period of volatility. The consequences for the U.S. and the global economy would be large. No one would be served well by this outcome. Federal Reserve Bank of St. Louis stlouisfed.org Federal Reserve Economic Data (FRED) research.stlouisfed.org/fred2/ James Bullard research.stlouisfed.org/econ/bullard/